India’s commodity exchanges have seen spectacular growth in trading volumes, liquidity, and participation. However, the agricultural commodity derivative segment has been losing sheen post-2016-17, and this downturn is attributed to declining trade and illiquid futures contracts.

Take the case of mentha oil futures, which has seen a declining trend in trading volume, open interest, and futures price since 2017-18.

What are the causes of this decline and what is the way ahead?

In India, mentha is grown on 3,27,000-3,34,000 hectares, producing about 33,000-35,000 tonnes, accounting for 80 per cent share globally. Uttar Pradesh has a lion’s share in mentha cultivation and processing, and export.

With the boom in demand for oil and its derivatives in export markets, mentha production continued to rise until 2010. However, with the entry of synthetic menthol, the demand, price and production of mentha were hit.

The commodity exchange launched mentha oil futures contract in May 2005 and gained momentum between 2010 and 2014, but started losing sheen from 2017. Until September 2017, the trading lot and delivery lot size used to be two drums (180 kg each drum). The delivery lot size was increased six-fold to 12 drums from October 2017 contract to align the trading lot with the sampling lot without increasing assaying cost.

The commodity exchange’s decision to align the trading lot with the delivery lot increased trading lot size and per unit assaying cost, which compelled many small traders to leave the market.

Further, the exchange introduced changes in the mentha oil futures contract specifications related to maximum allowable position limit and near-month open interest limit for clients and members. The reduction in open position limit has adversely affected the participation of hedge-limit users, mainly exporters and processors, and those interested in using the mechanism for delivery.

The exchange has enhanced the initial margin from 4 per cent of the unit contract value to 8 per cent and 12 per cent in early 2020. This coupled with the 1.25 per cent of extreme loss margin has impacted stakeholders’ participation.

We interviewed 64 mentha producers and 44 non-farmer stakeholders in Uttar Pradesh.

Despite a slump in mentha oil futures price, most farmers consider mentha production remunerative. However, they are not able to market the mentha derivative on the exchange platform.

The trading lot and delivery lot’s alignment has repercussions on the traders since the exposure has increased three-fold. For instance, before June 2020, the trading lot size was two drums, and the delivery lot size was 12 drums. It created an untenable situation for many small intra-day position traders and scalpers, resulting in their exit from the futures.

Due to the alignment issue of the trading lot and delivery lot the exchange effectuated in June 2020, traders and members are to incur additional expenses as the requirement for depositing the initial margin as a percentage of the unit futures contract value increased by 9.4 times the value of old trading lot size.

Revival measures

The commodity exchange in consultation with the commodity derivative market regulator can reduce the trading lot from 6 drums to 2 drums and increase the delivery lot size from 6 drums to 12 drums or maintain the current delivery lot with the rationalisation of the assaying costs.

The assayers should rationalise the per unit assaying cost of mentha oil. The regulator needs to work out initial margin requirements based on historical futures return volatility data and five to the seven-year output level of mentha and mentha oil. The regulator can reduce the initial margin from 12 per cent to 5-6 per cent of the unit contract value and add an extreme loss margin based on the Conditional Value at Risk measure. It can be implemented as an experimental basis given the market sentiment and magnitude of trading volume, and futures price trend. The exchange in consultation with the regulator can introduce the enhanced position limit and the near-month position limit to encourage exporters or processors to take hedge positions.

The state agricultural marketing board should address the pricing anomaly between quoted and traded mentha oil spot prices by initiating electronic trading and transaction.

Dey is Chairman and Gupta is Associate Professor of Centre for Food and Agribusiness Management, IIM, Lucknow. Views are personal.

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